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There’s something missing from the US economy, and nobody knows what it is

This article is more than 2 years old.

Economists are know-it-alls.

But even they admit they don’t actually know it all.

Take the basic recipe for economic growth, laid out in the 1950s by Nobel Prize-winning growth theorist Robert Solow. It calls for one part capital—investment in things like intellectual property, plants and factory machinery—one part labor, and one part, well, we don’t know.

Economists call the thing we don’t know “multifactor productivity” or if you want to get old school, the “Solow residual.” (It’s a residual, because it’s what’s left of economic growth, after you subtract out the parts that can be explained by labor and capital. It’s sort of like economic dark matter.) In other words, we know it’s there. We’re just not sure what it is.

There are theories. For example, some people used this number as proxy for intangibles like management innovations, or, the impact of new, efficiency-boosting technologies like the fax machine or the beeper or the Flowbee. For a decade, starting in the mid-1990s, US productivity soared, in what many saw as the result of major developments in communications and information technology being integrated into the economy.

Whatever it is, the US economy doesn’t have enough of it. Just-released figures from the US Bureau of Labor Statistics shows this economic dark matter at private nonfarm businesses increased at an annual rate of just 0.2% in 2015, down from 0.7% in 2014, and down even more from the 0.9% average between 1987 and 2015.

In his recent tome, the Rise and Fall of American Growth, University of Chicago economist Robert Gordon argues that in the aftermath of World War II, the US economy had a productivity boom that lasted into the 1960s, largely driven by the government-financed overhaul of the entire US industrial sector aimed at supporting the war effort. But since the early 1970s, productivity growth has been much weaker. From that perspective, the tech-driven productivity boom of the 1990s, was an the outlier.

Given how important productivity is to improving standards of living, this would seem to be a problem. So what can be done?

Well, no one is exactly sure. Some point to boosting investment—in capital equipment or research and development—as a key step if you expect to boost productivity. And that’s certainly true. The rise of China over the last 30 years has been driven by huge investments in productivity enhancing equipment in factories staffed by former farmers who have migrated to fast-growing cities.

But applying modern industrial technology to a Chinese economy stalled after decades of Maoist repression is as close as you can get to a sure thing in economics. It will almost certainly produce huge gains in productivity.

For already rich nations, the trick is to first invent, then develop and deploy,  new technologies and techniques that generate that special something upon interacting with human labor. And how you do that remains an economic mystery.

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